The residence nil rate band (RNRB), which comes into force over the next three tax years from 6 April, in a nutshell will enable couples with a home to pass on up to £1 million to their direct family free of inheritance tax.
But a survey by Old Mutual Wealth found an alarming level of ignorance about the RNRB. Seventy per cent of respondents knew nothing about the new rule, and even among those who considered themselves knowledgeable got some of the details wrong.
As things stand, the first £325,000 of someone’s estate is free of inheritance tax – an allowance known as the nil rate band (NRB). The new allowance will mean that someone who owns a home has an extra chunk of tax-free allowance. For estates worth more than £2 million the new allowance will be gradually tapered away.
However, it’s not a straightforward increase, and the survey revealed confusion over a number of aspects of the RNRB. ‘The lack of understanding around the new rules could result in people not structuring their will or their financial affairs in the most effective way,’ commented Old Mutual Wealth financial planning expert Rachel Griffin.
Here are the five areas of greatest misunderstanding:
1. YOU CAN SELECT WHICH PROPERTY THE ALLOWANCE IS SET AGAINST
Forty-five per cent of respondents did not realise the RNRB can be applied to any property (in or outside the UK) that has been used as a home by the deceased. ‘However, it does have to be within the scope of IHT, and the property or the value from the property must be included in the person’s estate,’ says Griffin.
2. THE ALLOWANCE WILL STILL APPLY EVEN IF THE PROPERTY HAS ALREADY BEEN SOLD
Forty-five per cent did not know the RNRB can be set against the value of a home that has previously been sold. That means people who have downsized or sold out of the market altogether are not penalised, as the allowance can be used within their estate against the value of their former family home.
3. OUTSTANDING MORTGAGE BORROWING IS DEDUCTED BEFORE THE ALLOWANCE IS APPLIED
‘The value of the home for RNRB purposes is the open market value of the property minus any liabilities secured on it, such as a mortgage,’ explains Griffin. Two fifths of respondents were not aware of this.
4. THE ALLOWANCE ONLY APPLIES WHEN THE PROPERTY (OR ITS VALUE) IS LEFT TO DIRECT DESCENDANTS
More than a third (36 per cent) did not understand that the property must be inherited by the child, grandchild or other direct descendant of the person who has died, or a direct descendant’s spouse or civil partner. ‘It’s important to note that direct descendants don’t include siblings, nieces and nephews or other relatives,’ adds Griffin.
5. THE ALLOWANCE WILL RISE PROGRESSIVELY OVER THE NEXT FOUR YEARS
Almost a third were not aware that the RNRB is set to increase from £100,000 per person in 2017/18, rising by £25,000 per tax year to £175,000 in 2020/21.
Given the potential for confusion over the new allowance, and the amount of tax that could potentially be saved by applying it correctly, the finding suggest expert advice makes sense for anyone thinking about estate planning, writing a will or restructuring their financial affairs.